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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





---




FORM 10-Q





|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------




For the quarterly period ended June 30, 2002





OR





| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------




For the transition period from
 to





Commission File Number 0-26016





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PALMETTO BANCSHARES, INC.


(Exact name of registrant as specified in its charter)





South Carolina

74-2235055(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer Identification No.)





301 Hillcrest Drive


Laurens, South Carolina  29360


(Address of principal executive offices)


(Zip Code)





(864) 984-4551


(Registrant's telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ̈





Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.





Class

Outstanding at August 14, 2002Common stock, $5.00 par value

6,301,578





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PALMETTO BANCSHARES, INC.





INDEX





Quarterly Report on Form 10-Q


For the Quarter Ended June 30, 2002





Page No.PART I .    FINANCIAL INFORMATIONItem 1.    Financial StatementsConsolidated Balance Sheets at June 30, 2002 and 2001 and December 31, 2001

1Consolidated Statements of Income for the three months ended June 30, 2002 and 2001

2Consolidated Statements of Income for the six months ended June 30, 2002 and 2001

3Consolidated Statements of Changes in Shareholders Equity and Comprehensive Income for the six months ended June 30, 2002 and 2001

4Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001

5Notes to the Consolidated Interim Financial Statements

6Item 2.    
Managements Discussion and Analysis of Financial Condition and Results of Operations

8Item 3.    
Quantitative and Qualitative Disclosures About Market Risk

26PART II.    OTHER INFORMATIONItem 1.    
Legal Proceedings

28Item 2.    
Changes in Securities and Use of Proceeds

28Item 3.    
Defaults Upon Senior Securities

28Item 4.    
Submission of Matters to a Vote of Security Holders

28Item 5.    
Other Information

29Item 6.    
Exhibits and Reports on Form 8-K

29SIGNATURES

30




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PART I.    FINANCIAL INFORMATION





Item 1.Financial Statements





PALMETTO BANCSHARES, INC.





CONSOLIDATED BALANCE SHEETS


(Dollars in thousands, except share data)





June 30, 2002


June 30, 2001


December 31, 2001(unaudited)


(unaudited)ASSETSCash and due from banks

$
32,939


$
32,783


$
27,742Federal funds sold


21,316



2,426



17,949Federal Home Loan Bank (FHLB) stock, at cost


1,733



1,733



1,733Investment securities available for sale


102,101



88,202



95,095Loans held for sale


4,147



11,202



10,054Loans


570,283



543,392



553,821Less allowance for loan losses


(5,867
)


(5,760
)


(5,658
)Loans, net


568,563



548,834



558,217Premises and equipment, net


19,789



17,422



19,175Accrued interest receivable


4,628



5,074



4,947Other assets


12,505



10,272



10,421Total assets

$
763,574


$
706,746


$
735,279LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing

$
105,444


$
105,490


$
102,679Interest-bearing


558,949



512,299



542,621Total deposits


664,393



617,789



645,300Securities sold under agreements to repurchase


17,306



13,578



15,313Commercial paper (Master notes)


14,401



11,857



11,076Other liabilities


3,853



7,720



4,522Total liabilities


699,953



650,944



676,211Shareholders EquityCommon stockpar value $5.00 per share; authorized 10,000,000shares; issued and outstanding 6,295,578,
6,262,734, and6,283,623 shares, respectively


31,478



31,314



31,418Capital surplus


44



40



26Retained earnings


30,941



24,063



27,386Accumulated other comprehensive income


1,158



385



238Total shareholders equity


63,621



55,802



59,068Total liabilities and shareholders equity

$
763,574


$
706,746


$
735,279





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.





CONSOLIDATED STATEMENTS OF INCOME


(Dollars in thousands, except share data) (Unaudited)





For the three months ended June 30,2002

2001Interest incomeInterest and fees on loans

$
10,297

$
11,177Interest and dividends on investment securities available for sale:U.S. Treasury and U.S. Government agencies


437


151State and municipal


498


674Mortgage-backed securities


107


310Interest on federal funds sold


153


75Dividends on FHLB stock


24


32Total interest income


11,516


12,419Interest expenseInterest on deposits


2,985


4,833Interest on securities sold under agreements to repurchase


50


138Interest on federal funds purchased





28Interest on commercial paper (Master notes)


37


98Total interest expense


3,072


5,097Net interest income


8,444


7,322Provision for loan losses


1,000


1,388Net interest income after provision for loan losses


7,444


5,934Noninterest incomeService charges on deposit accounts


1,982


2,099Fees for trust services


474


446Gains on sales of loans


193


141Investment securities gains


95


Other income


811


791Total noninterest income


3,555


3,477Noninterest expenseSalaries and other personnel


3,677


3,161Net occupancy


561


478Furniture and equipment


669


584FDIC assessment


37


27Postage and supplies


328


339Marketing and advertising


275


288Telephone


197


182Cardholder processing expense


147


123Sales finance losses


42


(6
)Other expense


1,376


1,229Total noninterest expense


7,309


6,405Income before income taxes


3,690


3,006Income tax provision


1,205


916Net income

$
2,485

$
2,090Net income per share-basic

$
0.40

$
0.33Net income per share-dilutive


0.38


0.32Cash dividends declared per share


0.11


0.10





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.





CONSOLIDATED STATEMENTS OF INCOME


(Dollars in thousands, except share data) (Unaudited)





For the six months ended June 30,2002

2001Interest incomeInterest and fees on loans

$
20,825

$
22,009Interest and dividends on investment securities available for sale:U.S. Treasury and U.S. Government agencies


748


423State and municipal


1,133


1,365Mortgage-backed securities


238


655Interest on federal funds sold


211


217Dividends on FHLB stock


50


67Total interest income


23,205


24,736Interest expenseInterest on deposits


6,252


9,932Interest on securities sold under agreements to repurchase


91


420Interest on federal funds purchased


1


43Interest on commercial paper (Master notes)


71


234Total interest expense


6,415


10,629Net interest income


16,790


14,107Provision for loan losses


1,900


2,238Net interest income after provision for loan losses


14,890


11,869Noninterest incomeService charges on deposit accounts


3,807


3,511Fees for trust services


931


945Gains on sales of loans


418


199Investment securities gains


235


Other income


1,535


1,424Total noninterest income


6,926


6,079Noninterest expenseSalaries and other personnel


7,356


6,235Net occupancy


1,109


1,029Furniture and equipment


1,304


1,154FDIC assessment


65


54Postage and supplies


710


693Marketing and advertising


530


513Telephone


390


371Cardholder processing expense


288


275Sales finance losses


66


14Other expense


2,664


2,264Total noninterest expense


14,482


12,602Income before income taxes


7,334


5,346Income tax provision


2,394


1,586Net income

$
4,940

$
3,760Net income per share-basic

$
0.79

$
0.60Net income per share-dilutive


0.76


0.58Cash dividends declared per share


0.22


0.20





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.





CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME


(Dollars in thousands, except share data)
(Unaudited)





Common Stock

Capital Surplus

Retained Earnings


Accumulated Other Comprehensive Income (Loss),
Net


TotalBalance at December 31, 2000

$
31,279

$
23

$
21,555


$
(264
)

$
52,593Net income








3,760







3,760Other comprehensive income, net of tax:Unrealized holding gains arising during period, net of tax effect of $406












649Less: reclassification adjustment for gains included in net income, net of tax effect of $0












Net unrealized gains on securities
















649Comprehensive income
















4,409Cash dividend declared








(1,252
)






(1,252
)Issuance of 7,000 shares in connection with stock options


35


17










52Balance at June 30, 2001

$
31,314

$
40

$
24,063


$
385


$
55,802Balance at December 31, 2001

$
31,418

$
26

$
27,386


$
238


$
59,068Net income








4,940







4,940Other comprehensive income, net of tax:Unrealized holding gains arising during period, net of tax effect of $667












1,065Less: reclassification adjustment for gains included in net income, net of tax effect of $90












(145
)Net unrealized gains on securities
















920Comprehensive income
















5,860Cash dividend declared








(1,385
)






(1,385
)Issuance of 11,955 shares in connection with stock options


60


18










78Balance at June 30, 2002

$
31,478

$
44

$
30,941


$
1,158


$
63,621





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(Dollars in thousands) (Unaudited)


For the six months ended June 30,2002


2001Cash flows from operating activitiesNet income

$
4,940


$
3,760Adjustments to reconcile net income to net cash provided by (used in) operating activitiesDepreciation and amortization


938



1,298(Gain) on sale of investment securities


(235
)


Provision for loan losses


1,900



2,238Origination of loans held for sale


(40,456
)


(41,366
)Sale of loans held for sale


46,781



30,974(Gain) on sale of loans


(418
)


(199
)Change in accrued interest receivable


319



155Change in other assets


(56
)


(641
)Change in other liabilities, net


(1,245
)


4,465Net cash provided by operating activities


12,468



684Cash flows from investing activitiesPurchase of investment securities available for sale


(50,123
)


(5,031
)Proceeds from maturities of investment securities available for sale


17,743



12,537Proceeds from sale of investment securities available for sale


23,925



Principal paydowns on mortgage-backed securities available for sale


2,928



3,925Net increase in loans outstanding


(19,996
)


(47,450
)Purchases of premises and equipment, net


(1,485
)


(1,716
)Net cash used in investing activities


(27,008
)


(37,735
)Cash flows from financing activitiesNet increase in deposit accounts


19,093



45,123Net increase (decrease) in securities sold under agreements to repurchase


1,993



(6,345
)Net increase (decrease) in commercial paper


3,325



(3,502
)Proceeds from issuance of common stock


78



52Dividends paid


(1,385
)


(1,252
)Net cash provided by financing activities


23,104



34,076Net increase (decrease) in cash and cash equivalents


8,564



(2,975
)Cash and cash equivalents at beginning of the period


45,691



38,184Cash and cash equivalents at end of the period

$
54,255


$
35,209Supplemental informationCash paid during the period for:Interest expense

$
6,741


$
10,772Income taxes


2,310



1,644Supplemental schedule of non-cash investing and financing transactionsChange in unrealized gain on investment securities available for sale, pre-tax

$
1,496


$
1,055Loans transferred to other real estate owned


1,843



376Loans chargedoff


1,770



2,044





See accompanying notes to consolidated interim financial statements.




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PALMETTO BANCSHARES, INC.





NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS





1.    GENERAL





Principles of Consolidation





The foregoing unaudited consolidated financial statements include the accounts of the Palmetto Bancshares, Inc.s (collectively defined as the Company), its wholly-owned subsidiary,
The Palmetto Bank (the Bank), and Palmetto Capital, Inc., the Banks wholly-owned subsidiary. In managements opinion, all significant intercompany accounts and transactions are eliminated, and all adjustments necessary for a
fair presentation of the results for interim periods presented have been included. Any such adjustments are of a normal and recurring nature.





Basis of Presentation





The unaudited consolidated interim
financial statements are presented in accordance with the instructions for Form 10-Q. Accordingly, certain information and footnotes required by generally accepted accounting principles for complete financial statements are not included herein. The
interim statements should be read in conjunction with the financial statements and footnotes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2001.





Summary of Significant Accounting Policies





The significant accounting policies used by the Company are described in Note 1 to the Companys Annual Report on Form 10-K for the year ended December 31, 2001. There have been no changes in
these policies subsequent to the year ended December 31, 2001.





Accounting Estimates and Assumptions





Certain policies require management to make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results could differ significantly from these estimates and assumptions.





2.    PER SHARE INFORMATION





Basic and diluted earnings per share have
been computed based on net income in the accompanying consolidated statements of income divided by the weighted average common shares outstanding or assumed to be outstanding as summarized below:





For the three months ended June 30,2002

2001BASICAverage common shares outstanding (denominator)

6,293,765

6,261,811DILUTEDAverage common shares outstanding

6,293,765

6,261,811Dilutive potential common shares

171,453

175,634Average diluted shares outstanding (denominator)

6,465,218

6,437,445




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For the six months ended June 30,2002

2001BASICAverage common shares outstanding (denominator)

6,290,529

6,260,425DILUTEDAverage common shares outstanding

6,290,529

6,260,425Dilutive potential common shares

171,198

172,967Average diluted shares outstanding (denominator)

6,461,727

6,433,392




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Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations





The following discussion and analysis is presented to assist in understanding the financial condition and results of operations of Palmetto Bancshares, Inc. and its subsidiary (the Company). This discussion should be read
in conjunction with the consolidated financial statements and related notes and other financial data appearing in this report as well as the Annual Report of Palmetto Bancshares, Inc. on Form 10-K for the year ended December 31, 2001. Results of
operations for the three month period ended June 30, 2002 are not necessarily indicative of results that may be attained for any other period. Percentage calculations contained herein have been calculated based upon actual, not rounded, results.





The holding company was organized in 1982 under the laws of South Carolina. Through its wholly-owned subsidiary,
The Palmetto Bank (the Bank), and the Banks wholly-owned subsidiary, Palmetto Capital, Inc. (Palmetto Capital), the Company engages in the general banking business in the upstate South Carolina market of Laurens,
Greenville, Spartanburg, Greenwood, Anderson, Cherokee, Abbeville, and Oconee counties (the Upstate). The Bank was organized and chartered under South Carolina law in 1906.





The Bank performs a full range of banking activities, including such services as checking, savings, money market, and other time deposits of various types of consumer and
commercial depositors; loans for business, real estate, and personal uses; safe deposit box rental and various electronic funds transfer services. The Bank also offers both individual and commercial trust services through an active trust department.
Palmetto Capital is a brokerage subsidiary of the Bank, which offers customers stocks, treasury and municipal bonds, mutual funds and insurance annuities, as well as college and retirement planning. The Banks sales finance department
establishes relationships with Upstate automobile dealers to provide customer financing of automobile purchases. The Banks mortgage banking operation continues to meet a broader range of its customers financial service needs by
originating, selling, and servicing mortgage loans.





FORWARD LOOKING STATEMENTS





This report contains certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) to assist in
the understanding of anticipated future operating and financial performance, growth opportunities, growth rates, and other similar forecasts and statements of expectations. These forward-looking statements reflect current views, but are based on
assumptions and are subject to risks, uncertainties, and other factors, which may cause actual results to differ materially from those in such statements. These factors include, but are not limited to, the following:





| |  |  | risks from changes in economic, monetary policy and industry conditions;
| | - |  | ------------------------------------------------------------------------




| |  |  | changes in interest rates, deposit rates, the net interest margin and funding sources;
| | - |  | --------------------------------------------------------------------------------------




| |  |  | market risk and inflation;
| | - |  | --------------------------




| |  |  | risks inherent in making loans including repayment risks and value of collateral;
| | - |  | ---------------------------------------------------------------------------------




| |  |  | loan growth, the adequacy of the allowance for loan losses and the assessment of problem loans;
| | - |  | -----------------------------------------------------------------------------------------------




| |  |  | fluctuations in consumer spending;
| | - |  | ----------------------------------




| |  |  | competition in the banking industry and demand for our products and services;
| | - |  | -----------------------------------------------------------------------------




| |  |  | dependence on senior management;
| | - |  | --------------------------------




| |  |  | technological changes;
| | - |  | ----------------------




| |  |  | ability to increase market share;
| | - |  | ---------------------------------




| |  |  | expense projections;
| | - |  | --------------------




| |  |  | changes in accounting policies and practices;
| | - |  | ---------------------------------------------




| |  |  | costs and effects of litigation; and
| | - |  | ------------------------------------




| |  |  | recently-enacted or proposed legislation.
| | - |  | -----------------------------------------






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Such forward-looking statements speak only as of the date on which such
statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain
statements in future filings by the Company with the Securities Exchange Commission, in press releases and in oral and written statements made by or with the approval of Palmetto Bancshares, Inc., which are not statements of historical fact,
constitute forward-looking statements.




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BALANCE SHEET REVIEW





Overview





Total assets
increased $28.3 million, or 4%, at June 30, 2002 over December 31, 2001 and reported a $56.8 million increase, or 8%, at June 30, 2002 over June 30, 2001. Liquid assets, which include cash, federal funds sold, and investments available for sale,
increased by $15.6 million, or 11%, at June 30, 2002 over December 31, 2001 and $32.9 million or 26% at June 30, 2002 over June 30, 2001. Total liabilities increased $23.7 million, or 4%, at June 30, 2002 over December 31, 2001 and reported a $49.0
million increase, or 8%, at June 30, 2002 over June 30, 2001. Total shareholders equity increased $4.6 million, or 8%, at June 30, 2002 over December 31, 2001 and reported a $7.8 million increase, or 14%, at June 30, 2002 over June 30, 2001.





Securities





At June 30, 2002, the Companys investment portfolio totaled $102.1 million compared to $95.1 million and $88.2 million at December 31, 2001 and June 30, 2001, respectively. This represents an
increase of 7% over December 31, 2001 and 16% over June 30, 2001. The composition of the investment portfolio at June 30, 2002 follows: agencies 41%, municipalities 38%, treasuries 15%, and mortgage-backed securities 6%.





During the first six months of 2002, the Bank purchased $50.1 million of investment securities (available for sale), $41.7 million of the
investment portfolio matured or was sold resulting in a gain of $235 thousand, and $2.9 million was paid down on mortgage backed securities held for sale. The June 30, 2002 securities balance included $1.5 million in pre-tax unrealized gains in the
portfolio.





During the first six months of 2001, the Bank purchased $5.0 million of investment securities
(available for sale), $12.5 million of the investment portfolio matured, and $3.9 million was paid down on mortgage backed securities held for sale. No securities were sold from the portfolio during the six month period ended June 30, 2001. The June
30, 2001 securities balance included $1.1 million in pre-tax unrealized gains in the portfolio.





Loans





At June 30, 2002, the Company had total loans outstanding of $574.4 million, which equaled 86% of total
deposits and 75% of total assets. Loans are the largest category of earning assets and generally produce higher yields than other earning assets. The loan portfolio consists principally of commercial loans, commercial real estate loans, consumer
loans, sales finance loans, and mortgage loans.





Loans held for sale were $4.1 million at June 30, 2002 compared
to $10.1 million and $11.2 million at December 31, 2001 and June 30, 2001, respectively. This represents a decrease of 59% over December 31, 2001 and 63% over June 30, 2001. As a result of the favorable interest rate environment for mortgage loans
and refinances, the Bank originated approximately $40.5 million in mortgage loans during the first six months of 2002, with substantially all being sold during the same period. The decrease in loans held for sale at June 30, 2002 over both December
31, 2001 and June 30, 2001 is a result of loans being committed at those period ends but not yet sold. At June 30, 2002 substantially all loans committed had been sold from the portfolio.





Loans excluding held for sale, net of unearned income, were $570.3 million at June 30, 2002 compared to $553.8 million and $543.4 million at December 31, 2001 and June 30,
2001, respectively. This represents an increase of 3% over December 31, 2001 and 5% over June 30, 2001. Management believes that the recent downturn in the economy has contributed to the relatively flat loan growth over the periods presented. The
Companys strategy is to allow for lower loan growth in




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times of economic downturn as opposed to attracting growth at the expense of low interest rate
positions.





See Credit Quality for additional discussion of loan portfolio performance.





Allowance for Loan Losses





The adequacy of the allowance is analyzed on a monthly basis. For purposes of this analysis, adequacy is defined as a level sufficient to absorb probable losses in the portfolio. The Bank uses an
allowance model that takes into account loan risk grades, delinquency trends, charge-off ratios as well as loan growth. Assessing the adequacy of the allowance is a process that requires considerable judgment. Managements judgements are based
on numerous assumptions about current events, which we believe to be reasonable. The allowance is subject to examination and adequacy testing by regulatory agencies.





The allowance for loan losses totaled $5.9 million at June 30, 2002 compared to $5.7 million and $5.8 million at December 31, 2001 and June 30, 2001, respectively. This
represents an increase of 4% over December 31, 2001 and 2% over June 30, 2001. Table 1 summarizes the changes in the allowance.





Table 1


Summary of Loan Loss and Recovery Experience


(Dollars in thousands)





At and for the six months ended June 30


At and for the year ended December 31, 20012002


2001Allowance at beginning of period

$
5,658


$
5,446


$
5,446Net charge-offs:Loans charged-off


1,770



2,044



4,033Less: loans recovered


79



120



2071,691



1,924



3,826Additions to reserves through provision for loan losses


1,900



2,238



4,038Allowance at end of period

$
5,867


$
5,760


$
5,658Average loans excluding held for sale

$
558,314


$
517,861


$
534,034Loans excluding held for sale, net unearned


570,283



543,392



553,821Net charge-offs as a % of average loans excluding held for sale (annualized, where applicable)


0.61
%


0.74
%


0.72
%Allowance as a % of loans excluding held for sale, net unearned


1.03



1.06



1.02





The allowance for loan losses as a percentage of loans excluding
held for sale increased to 1.03% at June 30, 2002 from 1.02% at December 31, 2001. The percentage decreased at June 30, 2002 over June 30, 2001 from 1.06% to 1.03%. During mid-1999 management noted deterioration in the performance of the sales
finance portfolio resulting in increased charge-offs during 2000 and 2001. The sales finance portfolio includes loans with more inherent risk than the loans in the Banks direct




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lending portfolio. Annualized (where applicable) net charge-offs as a percentage of average loans excluding held for sale have declined from 74
basis points at June 30, 2001 to 72 basis points at December 31, 2001 to 61 basis points at June 30, 2002. Additionally, it was noted that the sales finance portfolio has decreased to $14.2 million at June 30, 2002 from $15.9 at December 31, 2001
and $18.3 million at June 30, 2001.





See Credit Quality for additional discussion of factors
contributing to the allowance for loan losses.





Other Assets





At June 30, 2002, other assets totaled $12.5 million compared to $10.4 million and $10.3 million at December 31, 2001 and June 30, 2001,
respectively. This represents an increase of 20% over December 31, 2001 and 22% over June 30, 2001.





At June 30,
2002 major components of other assets included mortgage servicing rights which totaled $1.9 million, other real estate owned totaling $1.9 million, repossessed automobiles of $472 thousand, and $4.2 million of intangible assets related to four
branches purchases.





At December 31, 2001 other assets was comprised of mortgage servicing rights totaling $1.6
million, other real estate owned totaling $217 thousand, repossessed automobiles of $581 thousand, and $4.4 million of intangible assets.





At June 30, 2001 large components contributing to the balance of $10.3 million included mortgage servicing rights totaling $1.2 million, other real estate owned totaling $382 thousand, repossessed automobiles of $699
thousand, and $4.6 million of intangible assets.





The recent favorable interest rate environment as well as the
addition of originators has contributed to the increase we have seen in the loan portfolio at June 30, 2002 over December 31, 2001 as well as June 30, 2001. As noted in the Loans section above, originations of loans held for sale thus
far in 2002 have totaled $40.5 million. Since loans are typically sold servicing retained, synonymous with the increase in these loans is the increase in the Banks mortgage servicing portfolio as evidenced in the preceding paragraphs.





Total other real estate owned experienced only slight fluctuations between June 30, 2001 and December 31, 2001.
At June 30, 2002 real estate owned totaled $1.9 million, an increase of $1.7 million over December 31, 2001. Since December 31, 2001, the portfolio saw $1.8 million of additions offset by writedowns and sales. Ninety-five percent of the additions
were contained within four relationships with one relationship constituting forty-five percent.





As noted above in
the Allowance for Loan Losses section, during mid-1999 management noted deterioration in the performance of the sales finance portfolio. In the periods following these findings, charge-offs increased and collateral was repossessed, in
some cases, in conjunction with a portion of these sales finance loans. During the six month period ended June 30, 2002, the Bank has begun to experience a decrease in charge-offs (in part related to this portfolio). In addition, the balance of
repossessed automobiles has begun to decline. Resulting from the review of the loans within the portfolio, the sales finance portfolio has decreased to $14.2 million at June 30, 2002 from $15.9 at December 31, 2001 and $18.3 million at June 30,
2001.





The decline in the intangible asset balances is attributed to related amortization. Amortization for the
six month period ended June 30, 2002 was $218 thousand compared to $219 thousand for the same period ended June 30, 2001.





Deposits





At June 30, 2002, total deposits totaled $664.4 million compared to $645.3
million and $617.8 million




12




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##### Table of Contents

at December 31, 2001 and June 30, 2001, respectively. This represents an increase of 3% over December 31, 2001 and 8% over June 30, 2001.
Deposits remain the Banks primary source of funds for loans and investments. Deposits provided funding for 95% and 99% of average earning assets for the six month periods ended June 30, 2002 and 2001, respectively. Due to the stiff competition
that the industry has experienced in the recent past, this percentage has declined slightly. Deposit pricing remains very competitive. The composition of the deposit portfolio at June 30, 2002 follows: time deposits 44%, interest-bearing demand
deposits 34%, noninterest-bearing deposits 16%, and savings 6%.





Borrowed Funds





At June 30, 2002, total securities sold under agreement to repurchase totaled $17.3 million compared to $15.3 million and $13.6 million at
December 31, 2001 and June 30, 2001, respectively. This represents an increase of 13% over December 31, 2001 and 27% over June 30, 2001.





At June 30, 2002, total commercial paper totaled $14.4 million compared to $11.1 million and $11.9 million at December 31, 2001 and June 30, 2001, respectively. This represents an increase of 30% over December 31, 2001 and
21% over June 30, 2001.





As noted above in the Deposits section, deposits provided funding for 95% and
99% of average earning assets for the six month periods ended June 30, 2002 and 2001, respectively. Due to the stiff competition that the industry has experienced in the recent past, this percentage has declined slightly, opening the door for the
Company to obtain financing from other avenues. The increase in borrowed funds can be attributed to the higher balances of cash and due from banks, federal funds sold, investment securities and total loans only partially offset by the increase in
deposits.





Other Liabilities





At June 30, 2002, other liabilities totaled $3.9 million compared to $4.5 million and $7.7 million at December 31, 2001 and June 30, 2001, respectively. This represents a
decrease of 15% over December 31, 2001 and 50% over June 30, 2001.





The decrease in other liabilities at June 30,
2002 compared to December 31, 2001 of $669 thousand is the result of fluctuations in several accounts. Accrued income taxes decreased approximately $650 thousand at June 30, 2002 compared to December 31, 2001 based on the amount of income earned as
of both periods in time. As of December 2001 twelve months of income was taxable, while as of June 2002, only six months of income was taxable resulting in the decrease. FASB 115 taxes increased approximately $575 thousand due to an increase in the
unrealized gain on available for sale securities at June 30, 2002 over December 31, 2001. At June 30, 2002 the Company was in a deferred tax liability position of approximately $725 thousand while at December 31, 2001 we were in a deferred tax asset
position thereby leaving the liability account with a zero balance resulting in an increase in this account of $725 thousand. Accrued expenses decreased approximately $600 thousand at June 30, 2002 over December 31, 2001 due to contracts that renew
at year-end and therefore are not accrued at June 30, 2002. Escrow liability accounts increased approximately $195 thousand at June 30, 2002 over December 31, 2001 based on the fact that a large portion of these escrows relate to property taxes
which are paid soon before the end of a calendar year. Therefore, the balance of these accounts in December would be lower whereas June balances would have approximately six months accumulated resulting in a higher liability. The mortgage servicing
remittance account decreased approximately $390 thousand at June 30, 2002 over December 31, 2001. This account serves as a clearing account for loan sales and fluctuates on a day-to-day basis dependent on when monies are remitted for sales. The
final large fluctuation contributing to the decrease in other liabilities at June 30, 2002 over December 31, 2001 was a decrease in accrued interest payable of approximately $325 thousand. The fluctuation of this account results from the average
balances of interest-bearing deposits for the respective month as well as the cost of the interest-bearing balances for the month.




13




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##### Table of Contents

Although average interest-earning liabilities increased 3% from the month ended December 31, 2001 to the month ended June 30, 2002, the cost of
the interest-earning liabilities decreased from 2.33% for the month ended December 31, 2001 to 1.67% for the month ended June 30, 2002. The effect of this decrease of 66 basis points offsets the 3% increase in average interest-earning balances
resulting in a decrease in accrued interest payable at June 30, 2002 over December 31, 2001.





The decrease in
other liabilities at June 30, 2002 compared to June 30, 2001 of $3.9 million is the result of fluctuations in several accounts. FASB 115 taxes increased approximately $485 thousand due to an increase in the unrealized gain on available for sale
securities at June 30, 2002 over June 30, 2001. At June 30, 2002 the Company was in a deferred tax liability position of approximately $725 thousand while at June 30, 2001 we were in a deferred tax asset position thereby leaving the liability
account with a zero balance resulting in an increase in this account of $725 thousand. The mortgage servicing remittance account decreased approximately $4.1 million at June 30, 2002 over June 30, 2001. This account serves as a clearing account for
loan sales and fluctuates on a day-to-day basis dependent on when monies are remitted for sales. The final large fluctuation contributing to the decrease in other liabilities at June 30, 2002 over June 30, 2001 was a decrease in accrued interest
payable of approximately $600 thousand. The fluctuation of this account is a result of the average balances of interest-bearing deposits for the respective month as well as the cost of the interest-bearing balances for the month. Although average
interest-earning liabilities increased 9% from the month ended June 30, 2001 to the month ended June 30, 2002, the cost of the interest-earning liabilities decreased from 3.07% for the month ended June 30, 2001 to 1.67% for the month ended June 30,
2002. The effect of this decrease of 140 basis points offset the 9% increase in average interest-earning balances resulting in a decrease in accrued interest payable at June 30, 2002 over June 30, 2001.





Capital Resources and Dividends





Total shareholders equity totaled $63.6 million, $59.1 million, and $55.8 million at June 30, 2002, December 31, 2001, and June 30, 2001, respectively. Shareholders equity as a percentage
of total assets was 8% for each of the above periods in time. Increases in shareholders equity result from retention of earnings, unrealized gains in the available for sale security portfolio, and stock option exercises offset by dividends
paid.





Book value per share was $10.11 at June 30, 2002 compared to $9.40 and $8.91 at December 31, 2001 and June
30, 2001, respectively.





As of June 30, 2002, the Company and the Bank were in compliance with each of the
applicable regulatory capital requirements and met or exceeded the well-capitalized regulatory guidelines. Table 2 sets forth various capital ratios for the Company and the Bank. The Company and the Bank are subject to certain regulatory
restrictions on the amount of dividends they are permitted to pay. Based on the Banks current total risk-based capital ratio at June 30, 2002, the Bank had $6.2 million of excess retained earnings available for dividend payout and still be
considered well-capitalized.




14




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##### Table of Contents

Table 2


Capital Ratios





As of 6/30/02


Adequately Capitalized
Requirement


Well-Capitalized RequirementCompany:Total Risk-based Capital

11.17
%

8.00
%

10.00
%Tier 1 Risk-based Capital

10.15


4.00


6.00Tier 1 Leverage Ratio

7.66


4.00


5.00Bank:Total Risk-based Capital

11.07
%

8.00
%

10.00
%Tier 1 Risk-based Capital

10.05


4.00


6.00Tier 1 Leverage Ratio

7.62


4.00


5.00





Off-Balance Sheet Arrangements





The Companys off-balance sheet arrangements, which principally include lending commitments, are described below.





Lending commitments include loan commitments, standby letters of credit, and unused credit card lines. These instruments are
not recorded in the consolidated balance sheet until funds are advanced under the commitments. The Company provides these lending commitments to customers in the normal course of business.





For commercial customers, loan commitments generally take the form of revolving credit arrangements to finance customers working capital requirements. For retail
customers, loan commitments are generally lines of credit secured by residential property. Unused credit card lines are generally used for short-term borrowings. At June 30, 2002, these commitments totaled $100.9 million. Standby letters of credit
are conditional commitments to guarantee performance, typically contract or financial integrity, of a customer to a third party and totaled $1.7 million at June 30, 2002. The Company applies essentially the same credit policies and standards as it
does in the lending process when making these commitments.





Liquidity





Liquidity management ensures that adequate funds are available to meet deposit withdrawals, fund loan and capital expenditure commitments,
maintain reserve requirements, pay operating expenses, provide funds for dividends, and manage operations on an ongoing basis. Funds are primarily provided by the Bank through customer deposits, principal and interest payments on loans, loan sales,
securities available for sale, maturities of securities, and earnings.





Proper liquidity management is crucial to
ensure that the Company is able to take advantage of new opportunities as well as meet the demands of its customers. In this process, we focus on assets and




15




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##### Table of Contents




liabilities and on the manner in which they combine to provide adequate liquidity to meet our needs.





Investment securities are an important tool to our liquidity management. Securities classified as available for
sale may be sold in response to changes in interest rates, liquidity needs, and/or significant prepayment risk.





Net cash provided by operations and deposits from customers have been the primary sources of liquidity for the Company. Liquidity is also enhanced by the ability to acquire new deposits through the Banks established branch
network of 30 branches in South Carolina.





The Bank has access to borrowings from the FHLB and maintains
short-term lines of credit. At June 30, 2002, the Bank had approximately $76 million of unused borrowing capacity from the FHLB. The Bank has pledged assets to be used as collateral if the Bank takes advantage of the FHLB line of credit. At June 30,
2002, the Bank had unused short-term lines of credit totaling approximately $37 million (which are withdrawable at the lenders option). Management believes that these sources are adequate to meet its liquidity needs and to maintain the
liquidity ratio within policy guidelines.





The Company has certain cash needs including general operating expenses
and the payment of dividends and interest on borrowings. The Company currently has no long-term debt outstanding and has declared and paid cash dividends totaling $.22 per share in the six month period ended June 30, 2002. Although there can be no
guarantee that additional dividends will be paid in 2002, the Company plans to continue its quarterly dividend payments.





In the normal course of business, to meet the financial needs of its customers, the Company, principally through the Bank, enters into agreement to extend credit. For amounts and types of such agreements at June 30, 2002, see
Off-Balance Sheet Arrangements. Increased demand for funds under these agreements would reduce the Companys liquidity and could require additional sources of liquidity.





Credit Quality





A willingness
to take credit risk is inherent in the decision to grant credit. Prudent risk-taking requires a credit risk management system based on sound policies and control processes that ensure compliance with those policies. Adherence to underwriting
standards is managed through a multi-layered credit approval process and review of loans approved by lenders. Through loan review, reviews of exception reports, and ongoing analysis of asset quality trends, compliance with loan monitoring policies
is managed.





Table 3 presents information pertaining to nonperforming assets.




16




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##### Table of Contents




Table 3


Nonperforming Loans and Assets


(Dollars in thousands)





June 30


December 31, 20012002


2001Nonaccrual loans

$
2,697


$
2,834


$
3,399Loans past due 90 days still accruing interest


366



372



630Total nonperforming loans


3,063



3,206



4,029Other real estate owned


1,875



382



217Repossessed automobiles


472



699



581Total nonperforming assets


5,410



4,287


$
4,827Total nonperforming loans as a percentage of loans(1)


.54
%


.59
%


73
%Total nonperforming assets as a percentage of loans, other real estate owned, and repossessed
automobiles(1)


.94



.79



.87Allowance for loan losses as a percentage of nonperforming loans


1.92
x


1.80
x


1.40
x


---

|(1) |  | Calculated using loans excluding held for sale
|--- |  | ----------------------------------------------




Until the economy improves, credit quality indicators will remain volatile. While current economic data seems to be signaling improvement, the outlook remains uncertain. Management believes, however,
that loss exposure in its loan portfolio is identified, adequately reserved in a timely manner, and closely monitored to ensure that changes are promptly addressed in its analysis of allowance adequacy. Accordingly, management believes the allowance
as of June 30, 2002 is adequate, based on its assessment of probable losses, and available facts and circumstances then prevailing.




17




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##### Table of Contents

EARNINGS REVIEW





COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2002 AND 2001





Overview





Net income for the three months ended June 30, 2002 totaled $2.5 million, up 19%
compared with $2.1 million for the second quarter 2001. Earnings per diluted share for the second quarter 2002 were $0.38, a 19% increase from $0.32 per diluted share in the second quarter 2001. Earnings per basic share for the second quarter 2002
were $0.40, a 21% increase from $0.33 per basic share in the second quarter 2001.





Average common shares
outstanding on a diluted basis were 6.5 million in the second quarter 2002, up 0.43% from 6.4 million for second quarter 2001. Average common shares outstanding on a basic basis were 6.3 million in the second quarter 2002, relatively unchanged from
6.3 million in the second quarter 2001.





Noninterest income for the three months ended June 30, 2002 totaled $3.6
million, up 2% compared with $3.5 million for the second quarter 2001. Noninterest expense for the three months ended June 30, 2002 totaled $7.3 million, up 14% compared with $6.4 million for the second quarter 2001.





Net Interest Income





Net interest income is the difference between gross interest and fees on earning assets, primarily loans and investment securities, and interest paid on deposits and borrowed funds. The net interest margin measures how
effectively a company manages the difference between the yield on earning assets and the rate paid on funds to support those assets. Fully tax-equivalent net interest income adjusts the yield for assets earning tax exempt income to a comparable
yield on a taxable basis. Table 4 presents average balance sheets and a net interest income analysis on a tax-equivalent basis for the three months ended June 30, 2002 and 2001.





Fully tax-equivalent net interest income for the second quarter of 2002 increased $1.1 million, or 14%, to $8.7 million from $7.6 million in the second quarter of 2001. The
fully tax-equivalent net interest margin increased to 4.93% in the second quarter of 2002 from 4.83% in the second quarter of 2001.





Average earning assets grew $72.8 million, or 11%, to $707.1 million in the second quarter of 2002 from $634.2 million in the second quarter of 2001, primarily from the growth of federal funds sold, loans, and investment
securities. Average loans were $567.4 million during the second quarter of 2002 compared with $538.3 million during the second quarter of 2001. Average investment securities, including the average net unrealized securities gains, increased from
$88.1 million in the second quarter of 2001 to $101.9 million in the second quarter of 2002.





Average total
deposits increased from $593.7 million during the second quarter of 2001 to $663.9 million during the second quarter of 2002. Average borrowings increased to $33.6 million in the second quarter of 2002 from $29.2 million during the second quarter of
2001.




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##### Table of Contents




Table 4


Comparative Average BalanceYields and Costs


(Dollars in thousands)





For the three months ended June 30,2002


2001Average Balance


Income/ Expense

Yield/ Rate


Average Balance


Income/ Expense

Yield/ RateASSETSEarnings assetsFederal funds sold

$
35,610


$
153

1.72
%

$
5,870


$
75

5.12
%Federal Home Loan Bank stock and deposits


2,057



24

4.68



1,940



32

6.62Nontaxable investment securities(2)(3)


43,117



743

6.91



57,275



977

6.84Taxable investment securities(2)


58,825



544

3.71



30,855



461

5.99Nontaxable loans(3)


1,422



30

8.46



1,809



38

8.36Taxable loans, net of unearned(1)


566,024



10,277

7.28



536,488



11,151

8.34Total earning assets


707,055



11,771

6.68



634,237



12,734

8.05Nonearning assetsCash and due from banks


26,675









24,101Allowance for loan losses


(5,740
)








(5,401
)Premises and equipment, net


19,791









17,295Accrued interest


4,396









4,617Other assets


12,549









10,312Total nonearning assets


57,671









50,924Total assets

$
764,726








$
685,161LIABILITIES AND SHAREHOLDERS EQUITYLiabilitiesEarning liabilitiesDemand deposits

$
229,457


$
432

0.76
%

$
202,413


$
995

1.97
%Savings


38,042



62

0.65



32,367



119

1.47Time


293,265



2,491

3.41



266,745



3,719

5.59Total earning deposits


560,764



2,985

2.14



501,525



4,833

3.87Borrowings


33,555



87

1.04



29,209



264

3.63Total earning liabilities


594,319



3,072

2.07



530,734



5,097

3.85Nonearning liabilitiesNonearning deposits


103,182









92,207Other nonearnings liabilities


4,590









6,669Total nonearning liabilities


107,772









98,876Total liabilities


702,091









629,610Shareholders equity


62,635









55,551Total liabilities and shareholders equity

$
764,726








$
685,161NET INTEREST MARGIN (FTE)





$
8,699

4.93
%





$
7,637

4.83
%Tax-equivalent adjustment(3)





$
255








$
315


---

|(1) |  | Nonaccrual loans are included in average balances for yield computations. The effect of foregone interest income as a result of loans on nonaccrual was not
considered in the above analysis. All loans and deposits are domestic.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The average balances for investment securities include the unrealized gain or loss recorded for available for sale securities.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------

|(3) |  | The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. Yields on
nontaxable securities and loans are stated on a fully taxable equivalent basis, assuming the effective rate for the respective period. The adjustments made to convert nontaxable investments to a fully taxable equivalent basis were $245 and $303 for
the 2002 and 2001 periods, respectively. The adjustments made to convert nontaxable loans to a fully taxable equivalent basis were $10 and $12 for the 2002 and 2001 periods, respectively.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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The underlying factor for the changes in the yields and rates on earning assets
and costing liabilities has been the action of the Federal Reserve Open Market Committee during the past year. From January 2001 through the end of December 2001, the Federal Reserve cut interest rates four hundred and seventy five basis points.
Variable rate loans reprice immediately following changes in interest rates by the Federal Reserve. During the second quarter of 2002 as compared to the second quarter of 2001, the net interest margin improved, primarily from repricing certificates
of deposits at lower rates which was only partially offset by the decreasing yields of the loan and securities portfolios which was a direct result of the interest rate environment. The weighted average yield of the loan portfolio decreased from
8.34% for second quarter 2001 to 7.28% for second quarter 2002. The weighted average yield of the security portfolio decreased from 6.54% for second quarter 2001 to 5.06% for second quarter 2002. As the Company reduced its interest rates during the
year, the decline in the funding source rate outpaced the decline in the earning asset yield.





Provision for
Loan Losses





The provision for loan losses was $1.0 million and $1.4 million for the second quarter of 2002
and 2001, respectively. The provision is adjusted each month to reflect loan volume growth and allow for loan charge-offs, recoveries and other factors which impact managements assessment of the adequacy of the allowance for loan losses.
Managements objective is to maintain the allowance for loan losses at an adequate level to cover probable losses in the portfolio. Additions to the allowance for loan losses are based on managements evaluation of the loan portfolio under
current economic conditions, past loan loss experience, and such other factors, which in managements judgment deserve recognition in estimating loan losses.





During mid-1999 management noted deterioration in the performance of the sales finance portfolio that resulted in increased charge-offs during 2000 and 2001. See
Allowance for Loan Losses for discussion of this portfolio and the effect on the allowance for loan losses and, therefore, the provision for loan losses. This portfolio contributed to the increase in the provision during recent years as
a result of higher charge-offs. However, annualized net charge-offs as a percentage of average loans excluding held for sale have declined from 92 basis points for the quarter ended June 30, 2001 to 63 basis points for the quarter ended June 30,
2002. Just as charge-off trends contributed to the increase in provision for loan loss in prior years, they are now contributing to the decrease.





While management uses the best information available to make evaluations, future adjustments to the allowance in the form of provisions through the income statement may be necessary if economic
conditions differ substantially from the assumptions used in making the evaluation. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustment, based upon information that is
available to them at the time of their examination.





NonInterest Income and Expense





Noninterest income for the second quarter of 2002 increased $78 thousand, or 2%, to $3.6 million from $3.5 million in the
second quarter of 2001. Noninterest expense for the second quarter of 2002 increased $904 thousand, or 14%, to $7.3 million from $6.4 million in the second quarter of 2001.





Contributing to the increase in noninterest expense was an increase in salaries and personnel expense of $516 thousand for the three months ended June 30, 2002 over June
30, 2001. This increase is due in part to the opening of the Travelers Rest and Seneca branches during the first quarter of 2002 thereby increasing salaries and personnel expense related to the increase in personnel. Also contributing to the
noninterest expense increase was an increase in occupancy and furniture and equipment expense of $168 thousand for the three months ended June 30, 2002 over June 30, 2001, which is due in part to additional expenses related to the new branches.





Income Taxes





Income tax expense attributable to income from continuing operations increased to $1.2 million for the




20




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##### Table of Contents




second quarter of 2002 from $916 thousand for the second quarter of 2001. The effective income tax rate
as a percentage of pretax income was 33% for the second quarter of 2002 and 30% for the second quarter of 2001.





COMPARISON OF THE
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001





Overview





Net income for the six months ended June 30, 2002 totaled $4.9 million, up 31% compared with $3.8 million for the six months
ended June 30, 2001. Earnings per diluted share for the six months ended June 30, 2002 were $0.76, a 31% increase from $0.58 per diluted share for the same period in 2001. Earnings per basic share for the six months ended June 30, 2002 were $0.79, a
32% increase from $0.60 per basic share in the same period of 2001.





Average common shares outstanding on a
diluted basis were 6.5 million for the six months ended June 30, 2002, up 0.44% from 6.4 million for the same period of 2001. Average common shares outstanding on a basic basis were 6.3 million for the six months ended June 30, 2002, relatively
unchanged from 6.3 million from the same period of 2001.





Noninterest income for the six months ended June 30,
2002 totaled $6.9 million, up 14% compared with $6.1 million for the same period of 2001. Noninterest expense for the six months ended June 30, 2002 totaled $14.5 million, up 15% compared with $12.6 million for the same period of 2001.





Net Interest Income





Net interest income is the difference between gross interest and fees on earning assets, primarily loans and investment securities, and interest paid on deposits and borrowed funds. The net interest
margin measures how effectively a company manages the difference between the yield on earning assets and the rate paid on funds to support those assets. Fully tax-equivalent net interest income adjusts the yield for assets earning tax exempt income
to a comparable yield on a taxable basis. Table 5 presents average balance sheets and a net interest income analysis on a tax-equivalent basis for the six months ended June 30, 2002 and 2001.





Fully tax-equivalent net interest income for the six months ended June 30, 2002 increased $2.7 million, or 18%, to $17.4 million from $14.7 million for the six months
ended June 30, 2001. The fully tax-equivalent net interest margin increased to 5.03% for the six months ended June 30, 2002 from 4.74% for the six month period ended June 30, 2001.





Average earning assets grew $69.9 million, or 11%, to $696.2 million for the six months ended June 30, 2002 from $626.3 million for the same period of 2001, primarily from
the growth of federal funds sold, loans, and investment securities. Average loans were $566.5 million during the six month period ended June 30, 2002 compared with $524.0 million during the same period of 2001. Average investment securities,
including the average net unrealized securities gains, increased from $92.9 million for the six months ended June 30, 2001 to $102.7 million in the same period of 2002.





Average total deposits increased from $585.4 million for the six month period ended June 30, 2001 to $656.6 million during the same period of 2002. Average borrowings
decreased to $31.8 million for the six months ended June 30, 2002 from $32.8 million during the six month period ended June 30, 2001.




21




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##### Table of Contents




Table 5


Comparative Average BalanceYields and Costs


(Dollars in thousands)





For the six months ended June 30,2002


2001Average Balance


Income/ Expense

Yield/ Rate


Average Balance


Income/ Expense

Yield/ RateASSETSEarnings assetsFederal funds sold

$
25,011


$
211

1.70
%

$
7,532


$
217

5.81
%Federal Home Loan Bank stock and deposits


2,044



50

4.93



1,919



67

7.04Nontaxable investment securities(2)(3)


48,902



1,691

6.97



57,907



1,950

6.79Taxable investment securities(2)


53,756



986

3.70



34,959



1,078

6.22Nontaxable loans(3)


1,485



63

8.56



1,850



76

8.25Taxable loans, net of unearned(1)


565,050



20,783

7.42



522,149



21,956

8.48Total earning assets


696,248



23,784

6.89



626,316



25,344

8.16Nonearning assetsCash and due from banks


28,248









25,203Allowance for loan losses


(5,723
)








(5,433
)Premises and equipment, net


19,606









17,050Accrued interest


4,561









4,828Other assets


11,907









10,403Total nonearning assets


58,599









52,051Total assets

$
754,847








$
678,367LIABILITIES AND SHAREHOLDERS EQUITYLiabilitiesEarning liabilitiesDemand deposits

$
228,002


$
872

0.77
%

$
198,361


$
2,096

2.13
%Savings


36,697



128

0.70



31,594



257

1.64Time


291,266



5,252

3.64



264,684



7,579

5.77Total earning deposits


555,965



6,252

2.27



494,639



9,932

4.05Borrowings


31,750



163

1.04



32,770



697

4.29Total earning liabilities


587,715



6,415

2.20



527,409



10,629

4.06Nonearning liabilitiesNonearning deposits


100,638









90,757Other nonearnings liabilities


4,683









5,416Total nonearning liabilities


105,321









96,173Total liabilities


693,036









623,582Shareholders equity


61,811









54,785Total liabilities and shareholders equity

$
754,847








$
678,367NET INTEREST MARGIN (FTE)





$
17,369

5.03
%





$
14,715

4.74
%Tax-equivalent adjustment(3)





$
579








$
608


---

|(1) |  | Nonaccrual loans are included in average balances for yield computations. The effect of foregone interest income as a result of loans on nonaccrual was not
considered in the above analysis. All loans and deposits are domestic.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | The average balances for investment securities include the unrealized gain or loss recorded for available for sale securities.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------

|(3) |  | The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. Yields on
nontaxable securities and loans are stated on a fully taxable equivalent basis, assuming the effective rate for the respective period. The adjustments made to convert nontaxable investments to a fully taxable equivalent basis were $558 and $585 for
the 2002 and 2001 periods, respectively. The adjustments made to convert nontaxable loans to a fully taxable equivalent basis were $21 and $23 for the 2002 and 2001 periods, respectively.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------






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The underlying factor for the changes in the yields and rates on earning assets
and costing liabilities has been the action of the Federal Reserve Open Market Committee during the past year. From January 2001 through the end of December 2001, the Federal Reserve cut interest rates four hundred and seventy five basis points.
Variable rate loans reprice immediately following changes in interest rates by the Federal Reserve. During the six month period ended June 30, 2002 as compared to the same period of 2001, the net interest margin improved, primarily from repricing
certificates of deposits at lower rates which was only partially offset by the decreasing yields of the loan and securities portfolios which was a direct result of the interest rate environment. The weighted average yield of the loan portfolio
decreased from 8.48% for the six month period ended June 30, 2001 to 7.42% for the same period of 2002. The weighted average yield of the security portfolio decreased from 6.58% for the six month period ended June 30, 2001 to 5.26% for the same
period of 2002. As the Company reduced its interest rates during the year, the decline in the funding source rate outpaced the decline in the earning asset yield.





Provision for Loan Losses





The
provision for loan losses was $1.9 million and $2.2 million for the six month period ending June 30, 2002 and 2001, respectively. The provision is adjusted each month to reflect loan volume growth and allow for loan charge-offs, recoveries and other
factors which impact managements assessment of the adequacy of the allowance for loan losses. Managements objective is to maintain the allowance for loan losses at an adequate level to cover probable losses in the portfolio. Additions to
the allowance for loan losses are based on managements evaluation of the loan portfolio under current economic conditions, past loan loss experience, and such other factors, which in managements judgment deserve recognition in estimating
loan losses.





During mid-1999 management noted deterioration in the performance of the sales finance portfolio
that resulted in increased charge-offs during 2000 and 2001. See Allowance for Loan Losses for discussion of this portfolio and the effect on the allowance for loan losses and, therefore, the provision for loan losses. This portfolio
contributed to the increase in the provision during recent years as a result of higher charge-offs. However, annualized net charge-offs as a percentage of average loans excluding held for sale have declined from 74 basis points for the six months
ended June 30, 2001 to 61 basis points for the six months ended June 30, 2002. Just as charge-off trends contributed to the increase in provision for loan loss in prior years, they are now contributing to the decrease.





While management uses the best information available to make evaluations, future adjustments to the allowance in the form of provisions
through the income statement may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may
be subject to adjustment, based upon information that is available to them at the time of their examination.





NonInterest Income and Expense





Noninterest income for the six month period ended June 30,
2002 increased $847 thousand, or 14%, to $6.9 million from $6.1 million for the same period of 2001. Noninterest expense for the six month period of 2002 increased $1.9 million, or 15%, to $14.5 million from $12.6 million for the same six month
period of 2001.





Several factors contributed to the increase in noninterest income for the six month period ended
June 30, 2002 over 2001. Service charges on deposit accounts increased $296 thousand or 8% over the two periods. This increase was primarily due to the increase in deposit accounts over the two periods. Also contributing to the increase of
noninterest income was an increase in gain on sale of loans of $219 thousand and an increase in investment security gains of $235 thousand.





Several factors also contributed to the increase in noninterest expense for the six month period ended




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June 30, 2002 over 2001. The Company experienced an increase in salaries and personnel expense of $1.1 million for the six months ended June 30,
2002 over June 30, 2001. This increase is due in part to the opening of the Travelers Rest and Seneca branches during the first quarter of 2002 thereby increasing salaries and personnel expense related to the increase in personnel. Also contributing
to the noninterest expense increase was an increase in occupancy and furniture and equipment expense of $230 thousand for the six months ended June 30, 2002 over June 30, 2001 which is also related to additional expenses of the new branches. The
increase in other noninterest expenses of $400 thousand for the six month period ended June 30, 2002 over the same period of 2001 is due to an accumulation of small dollar changes in several accounts.





Income Taxes





Income tax expense attributable to income from continuing operations increased to $2.4 million for the six months ended June 30, 2002 from $1.6 million for the same period of 2001. The effective income tax rate as a
percentage of pretax income was 33% for the six month period ended June 30, 2002 and 30% for six month period ended 2001.




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ACCOUNTING AND REPORTING MATTERS





In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with
estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. The FASB has reminded its constituents that SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions still applies to bank acquisitions, and these acquisitions are thus excluded from the scope of
SFAS No. 142. As a result, any intangible asset created as a result of a branch acquisition would continue to be amortized in accordance with the provisions of SFAS No. 72. At December 31, 2001, the Company had unamortized intangible assets relating
to core deposit premiums purchased of $382 thousand as well as unamortized goodwill defined in SFAS 72 as an unidentifiable intangible asset (Statement 72 goodwill) of $3.9 million. Based on this information, the Company plans to
continue amortizing these assets as directed in SFAS No. 72. The Company has reviewed impairment in accordance with SFAS No. 142 as if it were applicable. Based on the results of the test, the Company believes that it does not have any impairment
during 2002.





In May, the FASB issued an exposure draft of the proposed statement, Acquisitions of Certain
Financial Statements, that would remove acquisitions of financial institutions from the scope of SFAS No. 72. The exposure draft, however, does not change the accounting for the acquisition of a branch. Specifically, the exposure draft states
that a branch acquisition that does not meet the definition of a business combination should be accounted for as an acquisition of net assets  a transaction that would not result in the recognition of goodwill. The exposure draft states,
The Board believes that for transactions that are not business combinations, the unidentifiable intangible asset represents finite-lived identifiable intangible assets that were not separately recognized or errors in measuring the fair value
of recognized assets acquired and liabilities assumed. Therefore, this Statement requires that the unidentifiable intangible asset continue to be amortized. The Company is currently reviewing past branch acquisitions to determine if they
qualify as business combinations and would then be accounted for under the provisions of SFAS No. 142. This determination will likely be finalized once the FASB has reviewed comments resulting from the exposure draft. As noted above, until this
time, the Company plans to continue amortizing these intangible assets as directed under SFAS No. 72.





Other
accounting standards that have been issued or proposed by the Financial Accounting Standards Board that do not require adoption until a further date are not expected to have a material impact on the consolidated financial statements upon adoption.




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Item 3.Quantitative and Qualitative Disclosures About Market Risk





Market risk is
the risk of loss from adverse changes in market prices and rates. The Companys market risk arises principally from interest rate risk inherent in its lending, deposit, borrowing and investing activities. Management actively monitors and
manages its inherent rate risk exposure. Although the Company manages other risks, such as credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be its most significant market risk. This risk
could potentially have the largest material effect on the Companys financial condition and results of operations. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal
course of the Companys business activities.





The Companys profitability is affected by fluctuations in
interest rates. Managements goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Companys earnings
to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same speed, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net
interest income using several tools.





At June 30, 2002, management believes that there have been no significant
changes in market risk as disclosed in the Companys Annual Report on Form 10-K for the year ended December 31, 2001.





The Banks goal is to minimize interest rate risk between interest-bearing assets and liabilities at various maturities through its Asset-Liability Management (ALM). ALM involves managing the mix and pricing of
assets and liabilities in the face of uncertain interest rates and an uncertain economic outlook. It seeks to achieve steady growth of net interest income with an acceptable amount of interest rate risk and sufficient liquidity. The process provides
a framework for determining, in conjunction with the profit planning process, which elements of the Companys profitability factors can be controlled by management. Understanding the current position and implications of past decisions is
necessary in providing direction for the future financial management of the Company. The Company uses an asset-liability model to determine the appropriate strategy for current conditions.





Interest sensitivity management is part of the asset-liability management process. Interest sensitivity gap (GAP) is the difference between total rate sensitive
assets and rate sensitive liabilities in a given time period. The Companys rate sensitive assets are those repricing within one year and those maturing within one year. Rate sensitive liabilities include insured money market accounts, savings
accounts, interest-bearing transaction accounts, time deposits and borrowings. The profitability of the Company is influenced significantly by managements ability to manage the relationship between rate sensitive assets and liabilities.





The following table is a summary of the Companys one year gap at June 30, 2002 (amounts in thousands):





June 30, 2002Interest-earning assets maturing or repricing within one year

$
230,416Interest-bearing liabilities maturing or repricing within one year

$
350,824Cumulative gap

$
(120,408
)Gap as a percentage of total assets


-15.77
%





The above analysis does not take in to account any prepayments on
mortgages, consumer or other loans, or securities. All maturities are stated in contractual terms. The Companys current GAP analysis reflects that in periods of increasing or decreasing interest rates, rate sensitive assets will reprice slower
than rate sensitive liabilities. The Companys GAP analysis also shows that at the interest repricing of one year, the Companys net interest margin would be adversely impacted by an increase in market interest rates. This analysis,
however, does not take into account the dynamics of the marketplace. GAP is a static measurement that assumes that if the prime rate increases by 100 basis




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points, all assets and liabilities that are due to reprice will increase by 100 basis points at the next
opportunity.





Because the Companys management feels that GAP analysis is a static measurement, it manages
its interest income through its asset/liability strategies that focus on a net interest income model based on managements projections. The Company has a targeted net interest income range of plus or minus twenty percent based on a 300 basis
point change over twelve months. The asset/liability committee meets weekly to address interest pricing issues, and this model is reviewed monthly. Management will continue to monitor its liability sensitive position in times of increasing interest
rates, which might adversely affect its net interest margin.




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PART II.    OTHER INFORMATION





Item 1.Legal Proceedings





On January 19, 2001, M. Snyders, Inc., an automobile
dealership that has sold and assigned sales finance contracts to the Bank, filed suit against the Bank and Richard O. Lollis, a former employee of the Bank who was the manager of the sales finance department. The suit was filed in the Court of
Common Pleas for Greenville County, South Carolina. M. Snyders claims arise from the sales finance contracts and its business relationship with the Bank, including causes of action for alleged breach of contract, breach of fiduciary duty,
fraud, negligent representation, breach of contract accompanied by fraudulent acts, unfair trade practices, negligence and negligent supervision; M. Snyders seeks actual and consequential damages. The Bank has filed counterclaims against M.
Snyders based on, among other things, alleged breach of contract with fraudulent intent, fraud, misrepresentations, unfair trade practices, bad faith, procurement of breach of contracts by customers and conversion of assets properly belonging
to the Bank. The Bank does not believe that M. Snyders claims are well founded and is vigorously pursuing its counterclaims and its defenses against the claims. In connection with the above lawsuit, the Bank has also filed a third party
complaint against an employee of M. Snyders, Inc. arising from his actions in dealing with sales finance contracts, including causes of action for fraud, misrepresentation and conversion. While the Bank does not anticipate a negative result
from this lawsuit, based on the apparent claims being asserted by the plaintiff, there can be no assurance that a negative result might not have a material adverse effect on the Companys financial condition.





In addition to the matter described above, from time to time the Bank is involved in legal proceedings incidental to its normal course of
business as a bank. Management believes that none of these proceedings is likely to have a materially adverse effect on the business of the Company or the Bank.





Item 2.Changes in Securities and Use of Proceeds





None





Item 3.Defaults Upon Senior Securities





None





Item 4.Submission of Matters to a Vote of Securities Holders





The annual
shareholders meeting of Palmetto Bancshares, Inc. was held on April 16, 2002. At the meeting the following directors were elected for the terms specified:





Term to Expire in 2005

Number of Votes FOR

Number of Votes AGAINST

Number of Votes ABSTAINEDJohn T. Gramling, II

4,962,047

-0-

1,000James M. Shoemaker, Jr.

4,960,447

1,600

1,000Edward K. Snead

4,962,047

-0-

1,000Paul W. Stringer

4,962,047

-0-

1,000





W. Fred Davis, Junior, David P. George, Junior, Michael D. Glenn,
William S. Moore, L. Leon Patterson, Sam B. Phillips, Jr., Ann B. Smith, and J. David Wasson continue in their present terms as directors.







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Item 5.Other Information





None





Item 6.Exhibits and Reports on Form 8-K





(a)  Exhibits





None





(b)  Reports on Form 8-K





None




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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





PALMETTO BANCSHARES, INC.By:

/s/    L. LEON
PATTERSONL. Leon Patterson Chairman and
Chief Executive OfficerBy:

/s/    PAUL W.
STRINGERPaul W. Stringer President and
Chief Operating Officer (Chief Accounting Officer)





Date:  August 14, 2002




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